HGH - Heartland Group Holdings

[Snoopy]

Yeap, I bought a Holden Calais V last year brand new.
3 year residuals are typically expressed as a percentage of the original retail prices I am sure you know. Some cars fare really well such as a Honda Civic which have their one fair price for all and don't do any discounting even for rental car firms and 3 year residuals can be as high as in the mid 60% range.

Residual value on Holdens are typically around 50% of original retail, (but nobody pays full retail for them), but will probably be less in the circumstances.

Thanks for the info. Let's say Holden's three year residuals work out at 45%, five percentage points less than budget. Why 45%?

The best selling Holden in NZ is the Colorado Ute.

https://www.stuff.co.nz/motoring/113...op-10-vehicles

"Colorado is currently selling at rate at least twice that of any other Holden."
"sales, may pass the 5000 mark by the end of the year."

The Holden Colorado is nothing more than a re-badged Isuzu D-max. The Isuzu D Max continues to be sold in NZ. So it would be hard to argue that second hand ute buyers would not recognize a bargain when they see one. Utes have a pretty good record of retained value anyway, so I don't think 50% retained value for the Colorado is out of the question. If all other Holden's retain 40% of their value and the Colorado is at 50% (representing half of all Holden financed sales) , then that makes for a 45% vehicle portfolio retained value average.

Now, over three years lets say the Holdem loan book totals $225m. Let's say Heartland take a one off hit on the difference between the booked retained value (45% vs 50%) and the actual retained value.

0.05 x $225m = $11m

Not nice for shareholders, but a one off $11m write-down looks manageable. A withheld dividend should more than cover it.

SNOOPY

[Beagle]

To be honest Snoopy I don't think it will be that much. Guaranteed future minimum values are usually set at very conservative level's of around 40-45% anyway and come with strict conditions in regard to mileage and vehicle condition.

[Snoopy]

'Business Finance' must be a worry. The problem here is that many of these loans would have been taken out in a business environment that could not have conceived of a business lock down such as we are in now. Having no revenue does not mean you are an incompetent business person today. For example, what would be the point in bankrupting a mall store owner, then on selling the bankrupt's assets to a new store owner who may be less competent? And who would take on a lease in a mall that is closed, and liable to be closed again at short notice anyway? The only solution I can see to this is a multi-party solution. Banks, premesis owners, and business operators will have to work together and take a 'joint hit'. If they don't then all three will lose, and lose big time. OK banks might get their money back, but then they will have no-one to lend to. I think we are going to have to move out of the lock down phase before anything can happen. 'And Grant Robertson has provided the liquidity to allow everyone to wait. And if there is no light after six weeks, Robertson will provide more liquidity. 'Liquidating at the bottom' would be three way commercial suicide for business owners and landlords and banks alike.

The 19th March Heartland update didn't read well for business loans

https://www.nzx.com/announcements/350143

"Heartland expects that new lending levels in some portfolios, such as business intermediated and SME, will slow."

But things were a bit more cheerful with the 2nd April response to the government support measures for business,

https://www.nzx.com/announcements/351120

"Heartland Bank has been contacting its business lending customers that are most likely to be financially affected by COVID-19, to discuss their support options. To that end, Heartland Bank is pleased to support the New Zealand Government’s Business Finance Guarantee Scheme, the details of which were announced yesterday. The Scheme enables Heartland Bank, alongside other participating banks, to provide new and existing qualifying business customers with annual turnover of between $250k and $80m with business loans to meet their urgent liquidity and bridging finance requirements while they deal with the disruption to their businesses caused by COVID-19. Heartland Bank looks forward to being able to offer customers that support option and is accepting registrations of interest on its website at www.heartland.co.nz/covid-19-update now."

Under the scheme, businesses with annual revenue between $250,000 and $80 million can apply to their banks for loans up to $500,000, for up to three years.

The real sting was in the next paragraph though:

"Importantly, a range of other support options may be available to all Heartland Bank customers who have been financially affected by COVID-19. All affected customers are encouraged to contact Heartland to discuss support available to meet their loan repayments."

IOW, Heartland would really prefer that businesses sort themselves out without using this particular government scheme. Quite understandable when under it, Heartland would wear 20% of any 'generous' loan that went bad. Other banks seemed to agree. On 1st May, rules around the scheme were changed removing the $250,000 minimum revenue cap and allowing businesses in the agricultural space to join.

https://www.interest.co.nz/banking/1...including-agri

"Secondly, the Government is removing the requirement for a “general security agreement” under the scheme."

"This means that for a loan of more than $50,000, a bank will no longer have to "obtain security from the borrower under a general security agreement". "

"Borrowers will no longer have to draw down on all existing facilities provided to them by their bank before applying for a loan under the scheme."

That last sentence is important. I think it means that Heartland can effectively transfer existing loans, or at least the incremental headroom on existing loans into the scheme. Ultimately Heartland could transfer 80% of the risk of a marginal existing loan to the government. As far as I understand the banking laws, this does not reduce the amount of capital that Heartland needs to hold to support such a loan. But it does support the downside loss of capital if the loan were to go bad.

More recently we have the "COVID-19 Small Business Cash Flow Loan (SBCS)" administered by the IRD.

https://www.interest.co.nz/business/...e-viable-small

"Robertson said it was necessary for the Government to write businesses loans directly, in addition to underwriting bank loans, as the latter isn't meeting businesses' needs nor the Government's expectations."

The new IRD administered scheme provides an interest free loan for one year for up to $11,800 for a sole trader, to $100,000 for a firm with up to 50 full time employees. The scheme is only open for a one month window commencing 12th May. This must be serious competition for Heartlands 'O4B' on line small business loans. Who would take out a $100,000 loan from Heartland if they could get the same thing from the IRD at no cost? I guess if the IRD loan scheme is extended beyond 12th June , Heartland's O4B might be declared dead. But in the current business environment, I am not sure if this is a negative or a positive!

So what does this picture suggest for profitability in FY2021?

'O4B' was 3% of the Heartland bank loan book in December 2019, with $158m of loans on the books.

Heartland has been earning an ROE of more than 15% on this O4B portfolio.
If O4B sinks, then the annual tax profit loss for Heartland will be about:

0.15 x $158m = $24m

That is likely an overestimate as O4B also offers partially secured loans of up to $250,000 (well beyond the $100,000 limit of the NZ government scheme) and secured and unsecured loans into Australia. Those boundaries are beyond the IRD scheme. I would estimate the actual annualised profit hit to be 80% of my calculated figure, or around $19m. I estimate the IRD loan scheme may have brought forward about three months worth of loan applications that otherwise might have gone through O4B. If the IRD scheme is dropped on 12th June as planned, then the impact flowing into FY2021 may only be a couple of months. That equates to a reduction in FY2021 profit of $19m x 2/12 = $3.2m.

If the remaining 'outside of government scheme boundary' loans profit of $5m were to sink by 10%, then that would knock $0.5m off annual profits going forwards.

Likewise if the residual O4B loan profit balance of $19m- $3.2m = $15.8m were to reduce by 10%, that would wipe $1.6m off annual profits.

Now putting these three effects together, the expected annual profit decreases from the base year of FY2019 are as follows:

FY2021: -$3.2m - $0.5m - $1.6m = -$5.3m
FY2022: - $0.5m - $1.6m = -$2.1m

SNOOPY

[Cyclical]

Thanks for the hard work you put into the analysis in your posts, Snoopy, makes for interesting reading. Hold, or fold do you think?

[Snoopy]

Heartland has an objective of growing their business loans in areas that the big banks are less interested in serving. Supplying Working Capital and funding for Plant and Equipment are two areas where Heartland can help. Who are the customers? Many are SMEs and stand alone professionals and tradespeople. Plumbers, Electricians and Designers may not always cross paths. But they have a common problem where finding capital is not always straightforward. Many have modest capital needs that are not a priority for big banks. Heartland will lend money on the basis of 'business performance' and not how much equity a prospective borrower has in their own home.

Heartland have also partnered with at least three intermediary 'FinTech' lenders. Heartland lending through intermediaries increased by $101.7m up 34% on the previous year to $425m at EOFY2019. This represents 38% of all categorised 'business lending' at balance date. That percentage is set to increase as the more traditional -but lower margin- in house 'business relationship lending' book is run down, Heartland's intermediaries are often lenders who have their own independent on line lending platforms. These providers don't need a physical office that customers can visit. Heartland is in fact pushing forward their own business loan expansion targets through these FinTech partners. The three partners they are on record as working with are as follows (see Annual Review FY2017, p13):

1/ 'Spotcap Australia and New Zealand' This company changed ownership on 6th September 2019 for $A9.3m (ZIP HY2020 p6) and is now managed as a division of ASX listed Zip Co. (ASX:ZIP). The purchase included $NZ7m of NZ based receivables and $A23m of Australian SME receivables. 'Spotcap' has been active in Australia since 2015 and active in New Zealand since January 2017. The average Australian loan has a size of $35,000 and has a duration of nine months. A potential New Zealand customer is required to have an 18 month trading history and a turnover north of $200,000. Loans available are in the $10,000 to $250,000 range. There were $A36.9m of receivable loan assets on the books as at 31st December 2019 (ZIP HY2020 Presentation p22). The competitive advantage that Spotcap claim to have is the IP related to their 'Proven SME credit decisioning platform'. However this IP is not owned. It is licensed perpetually from 'Spotcap Global', the Berlin-based FinTech that offers “lending as a service” decision systems around the world.

2/ 'Fuelled' is a New Zealand based start up that has been trading since 2015. The problem that 'Fuelled' was created to solve was to answer the question

"What happens when cashflow gets tight?"

'Fuelled' sees uncollected invoices as having value. So they will lend a company money before an invoice is paid to 'tide them over'. The relationship is purely between the company and 'Fuelled', not with the debtor. Any such transaction is confidential, no personal guarantees are required and costs are simple and transparent. (For example, an outstanding $10,000 invoice can receive $9000 from 'Fuelled', along with a fee of $471 for 30 days cover). 'Fuelled' partners with Xero and MYOB. It can use a customer's own on line information in the cloud to determine how much funding it can provide. This detailed information means that a request in the morning can turn to cash that afternoon. Heartland Bank has a 25% shareholding (a value less that $1m at the time of subscription) in 'Fuelled' bought on 20th February 2017. This investment funded 'Fuelled''s own equity/balance sheet and provided a credit line as well.

The vehicle that runs 'Fuelled' is on the NZ Company's register. "FUELLED LIMITED (5344042) Registered".

https://app.companiesoffice.govt.nz/...panies/5344042

The company last filed a return on 26th March 2019 and is now overdue to file the FY2020 return. It is under threat of de-registration as I write this. I cannot connect to the company website (www,fuelled.co.nz). Heartland note in their FY2018 presentation that they have made a gain on the sale of Heartland's 'invoice finance business' of $0.6m. I am not clear if this transaction is related to 'Fuelled' or not.

3/ 'Harmoney' (not a spelling mistake) started in 2014 as ostensibly a peer to peer lender, although they have always had wholesale debt funding as well. Sadly for the small guy, the entry level lender now needs - as of 1st April 2020 - a cool $10m to participate. So far the company has facilitated over $1.6 billion in loans to over 50,000 customers on both sides of the Tasman. Heartland took a 10% stake in Harmony on 8th September 2014. Heartland made a further investment in 'Harmoney' on 15th January 2015 for a total investment of $3.5m. The second investment was needed to retain Heartland's 10% stake after 'TradeMe' bought in as a cornerstone investor. Based on the investment made by 'Trade Me', the market value of Heartland's 10% stake in 'Harmoney' became worth $5m.

'Harmoney' use algorithm based credit checks. But the core values of the company are plugged into human needs.

Harmoney makes money by charging a platform fee to borrowers and a service fee to investors. The platform fee amount varies from 2% to 6% depending on the borrower's credit grade, while the service fee is 1.25% on all amounts the borrower pays. Borrowers pay either $200 or $450, depending on the size of the loan, if their loan is successfully funded.
Harmoney peer to peer investors earn money from interest and receive repayments from borrowers as they are made, proportionate to the percentage of the loan total they funded.

'Harmoney' core business proposition is to:

a/ be easy to use.
b/ be convenient to use (they are 100% on-line and open 24/7)
c/ have fair interest rates, based on a borrowers personal risk,

'Harmoney' reported their first profit, after an accounting standard change, of $7.22m over FY2019. Included in these calculations were a recognition of tax loss assets of $4.85m and deferred R&D expenses of $4.74m. Before these adjustments, 'Harmoney' lost $233,000 in the year to March 2019. At EOFY2019, 'Harmoney' had $367m of financial receivables on the books. Heartland's share of this receivables book amounted to:

0.131 x $367m = $48m.

So what does this picture suggest for profitability in FY2021?

'Business Relationship' lending fell by 16% in FY2019 to $559.4m (Annual Review FY2019 p9), and I expect this trend to continue into FY2020 and FY2021. This means I am projecting the 'Business Relationship' loan book to be down to:

$559.4 x 0.84 x 0.84 = $395m

That number corresponds to the receivables book shrinking by $165m. We are told ROE for these loans is between 0% and 11% (AGM2019 Presentation p15). If the closed out loans averaged an ROE of 6%, this would represent a drop in Heartland profit from FY2019 levels of:

$165m x 0.06 = $10m

I am predicting that when some of the lending through intermediaries starts to shrink, Heartland will renew their interest in writing business relationship loans directly. So I see no further shrinkage in profit from this category between FY2021 and FY2022.

'Business Intermediated' lending is projected to grow in FY2020.

But I think that by FY2021, it will shrink back down 10% below FY2019 levels (down to $425.4m x 0.9 = $383m, a decrease of $42m). My reason for believing this is that there will be lower tradie activity in FY2021, and sensible tradespeople will have transferred to IRD backed ultra low interest loans, at least in NZ. The silver lining of this is that by existing Heartland customers effectively refinancing with the government, many bad debts to Heartland will be avoided. Business Intermediary loans have an ROE of between 11% and 15% (AGM2019 Presentation p15). If we assume the average margin is 13%, this will represent a loss of profit for Heartland in FY2021 of:

$42m x 0.13 = $5.5m

The kind of business loans sought by Heartland tend to be short term. So I am not expecting the general reduction in business loans to have a compounding effect year on year.

SNOOPY

[Snoopy]

Thanks for the hard work you put into the analysis in your posts, Snoopy, makes for interesting reading. Hold, or fold do you think?

I don't think Heartland is going to go out of business. So the question is what price is fair value for investment? I still remember New Zealand's second greatest ever banker, the late Sir John Anderson, standing up at a special PGW meeting called to sell off the highly successful PGW Finance business. He stated that even a really good finance business is only worth its asset backing. Sir John was PGW Chairman at the time. That was immediately post GFC. Fast forward to Heartland post Covid. Would Sir John be saying the same thing if he was still with us today?

SNOOPY

[nevchev]

I don't think Heartland is going to go out of business. So the question is what price is fair value for investment? I still remember New Zealand's second greatest ever banker, the late Sir John Anderson, standing up at a special PGW meeting called to sell off the highly successful PGW Finance business. He stated that even a really good finance business is only worth its asset backing. Sir John was PGW Chairman at the time. That was immediately post GFC. Fast forward to Heartland post Covid. Would Sir John be saying the same thing if he was still with us today?

SNOOPY

So what is fair value here Snoopy?Still alot of unknowns to work thru.

[Snoopy]

Yeap, all that no deposit unsecured lending to Harmoney is super safe...what could possibly go wrong lol

Sorry to pose an awkward question but....

Where does the Harmoney lending appear in the Heartland annual accounts? I will accept answers from allcomers (not just Beagle).

And yes, there is a reason for asking that question!

SNOOPY

[Snow Leopard]

Harmoney & the like are filed under Other Personal in the Accounts.

[King1212]

Broker slapped $1.54 target price